March 7, 2014
Issue No: 14/10
US Economics Analyst
Economics Research
Keeping the Faith in Cap-ex Recovery
Jan Hatzius

A pickup in capital spending is one factor behind our forecast for faster
US GDP growth in 2014. US cap-ex disappointed consensus forecasts
over the past year, as did cap-ex across other major developed
markets. The past year’s underperformance has raised some concern
about the likelihood of solid growth in coming quarters.
(212) 902-0394 jan.hatzius@gs.com
Goldman, Sachs & Co.
Alec Phillips
(202) 637-3746 alec.phillips@gs.com
Goldman, Sachs & Co.
Jari Stehn


A cross-country analysis of developed market capital spending
suggests that key drivers include (1) “accelerator” effects from growth
in other sectors, (2) economic uncertainty, (3) the market value of
assets relative to replacement value, and (4) mean-reversion effects.
Three of these four factors should be substantially more positive for
cap-ex in 2014 than they were in 2013.
Specifically, growth outside of capital spending should rise―due to a
combination of lower fiscal drag and gains in consumer
spending―inducing higher capital investment.
The degree of
economic uncertainty, both on US fiscal policy and with regard to tail
risk scenarios in the Eurozone, has declined considerably. The market
value of assets relative to their replacement value has risen further.

In addition, US capital spending over the four quarters of 2013 was
depressed by a tax distortion which pulled nonresidential construction
spending forward into 2012. Based on our current tracking forecast for
Q1, the year-on-year growth rate for US business fixed investment is
likely running around 5½%, compared with only 3% in 2013.

In order to peek further ahead at the global cap-ex cycle, we construct
a developed markets cap-ex leading indicator (CLI). This indicator is
based on surveys of cap-ex intentions from the US, Canada, Germany,
Japan, and the UK. After reaching a trough in 2012 Q4, the CLI has
risen gradually over the past year, and points to improving cap-ex
growth in coming quarters.
(212) 357-6224 jari.stehn@gs.com
Goldman, Sachs & Co.
Kris Dawsey
(212) 902-3393 kris.dawsey@gs.com
Goldman, Sachs & Co.
David Mericle
(212) 357-2619 david.mericle@gs.com
Goldman, Sachs & Co.
Shuyan Wu
(212) 902-3053 shuyan.wu@gs.com
Goldman, Sachs & Co.
Michael Cahill
(801) 884-4621 michael.e.cahill@gs.com
Goldman, Sachs & Co.
Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification
and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html.
The Goldman Sachs Group, Inc.
Global Investment Research
March 7, 2014
US Economics Analyst
Keeping the Faith in Cap-ex Recovery
A pickup in capital spending is one factor behind our forecast for faster US growth in 2014.
However, disappointing cap-ex last year has raised questions about the likelihood of a
return to solid growth in 2014. Indeed, disappointing capital spending in 2013 was not
limited to the US, but was a theme seen across developed markets (Exhibit 1).
Complementing our past work, this week’s US Economics Analyst takes a more global
perspective, assessing the determinants of, and the outlook for, cap-ex across developed
markets. The results increase our confidence in our forecast for a pickup in real US
business fixed investment in 2014 to a bit more than 7%, up from roughly 3% last year.
The results are also consistent with our Portfolio Strategy team’s forecast that S&P 500
cap-ex spending will rise by 9% vs. 2% last year, on a nominal basis.1
Exhibit 1: Cap-ex was a Global Disappointment in 2013
Percent change, year ago
Percent change, year ago
6
6
5
5
Business Investment
4
Consensus Forecast (start of 2013)
4
3
Actual
3
2
2
1
1
0
0
-1
-1
-2
-2
-3
-3
USA*
Japan*
Germany#
France*
UK^
Canada#
* Business investment, # Machinery & equipment investment, ^ Gross fixed investment.
Source: Blue Chip, Consensus Economics (January 2014, January 2013).
Capital Spending Well Explained by Fundamental Models
In past work, we found that current and lagged consumption growth (i.e., “accelerator
effects” 2 ), mean-reversion effects, credit conditions, and return on assets are good
predictors of year-ahead cap-ex.3 Here, we extend this work to a panel of developed
countries, slightly adjusting the set of explanatory variables due to data limitations. These
limitations are especially challenging with regard to internationally comparable measures
of credit conditions. As a supplement to what we have included in past work, we add
economic uncertainty (often cited by business leaders as a reason for delaying investment)
and the domestic stock market price-to-book ratio (P/B) as a rough proxy for “Tobin’s Q,”
the market value of assets relative to their replacement value.4
Exhibit 2 shows the results of a set of regressions of year-ahead real business fixed
investment on these explanatory variables. The dataset is quarterly since 1990 (to the
1
See David Kostin. “Defending Spending: Company guidance implies capex acceleration in 2014.” US Weekly
Kickstart. February 21, 2014.
2
Accelerator effects refer to the tendency for growth outside of cap-ex to “pull in” investment, as businesses
erring on the side of caution given the irreversibility of many investment decisions respond to actual revenue
growth more strongly than anticipated revenue growth.
3
See David Mericle. “A Closer Look at the Capital Spending Drought.” US Daily. October 14, 2013.
4
See William Brainard and James Tobin. “Pitfalls in Financial Model Building.” American Economic Review 58 (2).
1968.
Goldman Sachs Global Investment Research
2
March 7, 2014
US Economics Analyst
extent available), including the US, Canada, France, Germany, and the UK.5 The leftmost
column depicts the results of a panel regression including country fixed effects, while the
remaining columns show the results of individual regressions by country. While not all
factors enter significantly in the expected direction in every country, it is clear from these
results that the factors which appear important for driving US cap-ex are generally also
important for other developed economies.6
Exhibit 2: Fundamental Models of Developed Market Cap-ex
Fundamental Models of Investment Growth
Dependent variable: average growth in real BFI over next four quarters
Panel*
USA
Germany France
Consumption Growth (%)
0.81
0.85
0.22
0.59
(5.62)
(3.14)
(0.78)
(1.90)
Consumption Growth, 1 lag (%)
0.37
0.72
0.10
0.49
(2.59)
(2.82)
(0.36)
(1.77)
Policy Uncertainty Index (z-score)
-0.80
-1.61
-1.98
-0.07
(-2.02)
(-2.38)
(-1.92)
(-0.11)
Stock Market P/B Ratio
1.59
3.85
6.66
-1.34
(2.22)
(3.07)
(4.32)
(-1.02)
Investment Share of GDP (%)
-2.91
-6.15
-6.49
-5.46
(-8.97)
(-6.92)
(-6.97)
(-7.32)
R^2
0.33
0.65
0.51
0.64
N
369
92
65
68
UK
0.64
(2.03)
0.14
(0.46)
-0.66
(-0.77)
7.73
(2.80)
-3.22
(-3.77)
0.34
68
Canada
0.99
(2.40)
0.03
(0.08)
0.48
(0.35)
-3.51
(-1.26)
-2.34
(-2.69)
0.27
62
*Estimated with country fixed effects. Note: T-stats in parentheses.
Source: Goldman Sachs Global Investment Research.
Investment Drivers Should Improve in 2014
Of the four key drivers included in our international capital spending models, three point to
improved investment growth this year. Our forecast for US real personal consumption
expenditures calls for growth of 3.2% by the second half of the year, following 2.3% over
the comparable period in 2013, and 1.7% over the comparable period in 2012. This gradual
improvement in consumer spending should draw in greater business investment, as firms
respond to higher demand. Importantly, the forecasted pickup in consumer spending is
largely independent of our forecast for higher cap-ex, mainly following from reduced drag
from the $200bn in tax increases seen in 2013, the lagged impact of substantial gains in
both housing and stock market wealth last year, and easier consumer credit standards.
Economic uncertainty, as measured by the Baker, Bloom, and Davis (2013) uncertainty
index has also declined substantially over the past two years.7 We have expressed some
skepticism about this index in the past because it is hard to be sure whether higher
uncertainty was a cause or effect of economic weakness in 2008-2012. But we think that
the recent decline looks more clearly like an exogenous consequence of the fiscal thaw in
Washington. Elsewhere in the world, focus on tail risk scenarios for the Eurozone has
significantly subsided, despite the short-lived spike in concern around Cyprus last year. To
the extent global cap-ex forecasts proved too optimistic in 2013—as we noted previously—
5
We exclude Japan because a metric of economic uncertainty is not available for the country. For further
information on the state of investment in Japan see Naohiko Baba. “Equity rally is good news for capex, but full
recovery comes only from growth strategies.” Japan Economics Analyst. May 2, 2013.
6
Although we find that consumption growth provides the best proxy for the accelerator effect in the full sample of
countries and for the United States taken individually, real GDP growth ex-business investment performs slightly
better for Germany, likely due to its stronger export orientation.
7
Scott Baker, Nicholas Bloom, Steven Davis. “Measuring Economic Policy Uncertainty.” May 19, 2013. This
index is available for the US, Canada, France, Germany, and the UK, as well as several other countries.
Goldman Sachs Global Investment Research
3
March 7, 2014
US Economics Analyst
an incomplete appreciation of the lagged negative effects of heightened uncertainty may
have been to blame.
Exhibit 3: Economic Uncertainty Declined in 2013
Index
Index
250
250
Greek spreads
widen sharply,
Spain
downgraded
200
Financial crisis
erupts
US debt
ceiling
standoff
Greek referendum
speculation
Crisis in
Cyprus
US
government
shutdown
200
150
150
US
100
100
Europe
50
2007
50
2008
2009
2010
2011
2012
2013
2014
Source: PolicyUncertainty.com.
Solid gains in global stock indices last year strongly suggest that the market value of assets
has increased relative to their replacement value. Although comparable cross-country data
on “Tobin’s Q” are not readily available, the correlation between a measure derived from
the US Flow of Funds accounts and the simple price-to-book (P/B) ratio of the S&P 500
index is quite high (Exhibit 4). As a result, we are comfortable using P/B ratios for global
stock indices as a rough proxy for country-specific Q measures. With the market valuing
assets at a higher multiple—including property, plant, and equipment—this argues for
faster growth in investment.
Exhibit 4: Existing Assets Seen as More Valuable
6
Ratio
Ratio
3.5
S&P 500 P/B (left)
5
3
US Tobin's Q (right)
2.5
4
2
3
1.5
2
1
1
0
1990
0.5
0
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Source: FactSet. IBES Datastream. Federal Reserve Board. Goldman Sachs Global Investment Research.
US Capital Spending Growth in 2013 Deserves a Second Look
On top of the fundamental reasons for anticipating an acceleration in the capital stock in
2014, there are strong reasons to believe that the roughly 3% rate of US cap-ex growth in
2013 was artificially depressed. Most importantly, nonresidential structures investment
Goldman Sachs Global Investment Research
4
March 7, 2014
US Economics Analyst
collapsed at a 26% annual rate in Q1 of last year, pulling down overall business fixed
investment growth to -4½%. This compared with an average of about +5½% for the
remaining three quarters of the year. The decline in nonresidential structures investment
was mostly due to a drop in power-related structures, which in the event, turned out to be
caused by accelerated construction of windmills in late 2012 in a rush to qualify for
expiring renewable energy production tax credits. (A very similar distortion occurred in
early 2011.) The effect of this tax policy distortion was to pull forward investment into 2012
at the expense of 2013. Once we “lap” the effect of this distortion, the year-on-year growth
rate through 2014 Q1 should be roughly +5½%, based on our current tracking estimate.
Global Leading Indicators of Cap-ex are Looking Up
After outlining the fundamental case for stronger cap-ex, it is natural to ask whether
business leaders say that they intend to increase investment spending in the near term. In
order to answer this question in a systematic way, we create a developed markets cap-ex
leading indicator (CLI), incorporating nine different cap-ex-related surveys from five
countries.8 The indicator is constructed in a similar fashion to our current activity indicator
(CAI), by taking a principal component of the normalized underlying series and re-mapping
the factor to more natural units, in this case, annualized growth in business fixed
investment. Exhibit 5 shows the tracker, which bottomed in 2012 Q4 and has gradually
increased over the past year, currently pointing to a substantial pickup in developed market
cap-ex growth in the coming quarters. During 2013 Q4, eight out of nine components
advanced relative to the prior quarter.
Exhibit 5: Developed Market Cap-ex Leading Indicator Points North
Percent change, year ago
15
Percent change, year ago
15
10
10
5
5
0
0
-5
-5
-10
-10
Cap-ex Leading Indicator
-15
-20
2000
-15
G7 Cap-ex (ex-Italy)
-20
2002
2004
2006
2008
2010
2012
2014
Source: OECD. IMF. Goldman Sachs Global Investment Research.
The CLI broadly corroborates our Portfolio Strategy team’s bottom-up tabulation of cap-ex
guidance from S&P 500 company management, which suggests 7% growth in 2014.
Overall, these results make us more confident in our call for an eventual pickup in US capex during the coming year.
Kris Dawsey
8
The constituents are the Duke/CFO Magazine index of cap-ex intentions (US), the 4Q change in the NFIB cap-ex
index (US), the new work component of the Architectural Billings Index (US), the BoC Business Outlook’s
machinery & equipment investment intentions component (Canada), the DIHK investment survey (Germany),
profit expectations for the machinery sector in the ZEW survey (Germany), the Shoko-Chukin industrial capacity
survey (Japan), and the BoE Agents’ investment survey for both manufacturing and service industries (UK).
Goldman Sachs Global Investment Research
5
March 7, 2014
US Economics Analyst
The US Economic and Financial Outlook
(% change on previous period, annualized, except where noted)
2012
2013
2014
(f)
2015
(f)
2016
(f)
Q1
2013
Q2
Q3
Q4
Q1
2014
Q2
Q3
Q4
OUTPUT AND SPENDING
Real GDP
Consumer Expenditure
Residential Fixed Investment
Business Fixed Investment
Structures
Equipment
Intellectual Property Products
Federal Government
State and Local Government
Net Exports ($bn, '09)
Inventory Investment ($bn, '09)
Industrial Production, Mfg
2.8
2.2
12.9
7.3
12.7
7.6
3.4
-1.4
-0.7
-431
58
3.9
1.9
2.0
12.1
2.8
1.4
3.1
3.4
-5.2
-0.2
-412
83
2.2
2.8
2.5
5.6
6.5
6.6
6.9
5.9
-3.0
0.9
-392
81
3.0
3.2
2.8
12.4
6.8
5.9
8.1
5.4
-1.4
1.9
-405
75
3.7
3.0
2.5
12.5
5.5
5.0
6.1
5.0
-1.3
2.0
-415
85
3.5
1.1
2.3
12.5
-4.6
-25.7
1.6
3.8
-8.4
-1.3
-422
42
4.9
2.5
1.8
14.2
4.7
17.6
3.2
-1.5
-1.6
0.4
-424
57
0.1
4.1
2.0
10.3
4.8
13.4
0.2
5.7
-1.5
1.7
-420
116
1.5
2.4
2.6
-8.8
7.3
0.2
10.5
8.0
-12.8
-0.5
-383
117
4.7
1.7
2.0
4.9
4.7
4.5
3.9
6.0
0.0
0.8
-384
100
2.2
3.0
3.2
9.0
8.1
7.5
10.0
6.0
0.0
1.5
-394
84
3.5
3.5
3.2
13.0
8.2
7.5
10.0
6.0
0.0
1.5
-397
74
4.0
3.5
3.2
13.0
8.2
7.5
10.0
6.0
-3.0
2.0
-395
66
4.0
783
368
4,659
5.4
931
430
5,073
9.2
1,090
502
5,067
4.1
1,333
626
5,319
3.2
1,536
749
5,429
2.4
957
449
4,927
7.9
869
442
5,100
8.9
882
388
5,323
10.0
1,016
441
4,943
9.2
950
464
4,850
7.3
1,082
486
5,074
5.6
1,136
514
5,139
4.3
1,193
545
5,203
4.1
2.1
2.1
1.8
1.5
1.8
1.2
1.6
1.7
1.3
1.9
1.9
1.6
2.1
2.1
1.8
1.7
1.9
1.5
1.4
1.7
1.2
1.5
1.7
1.2
1.2
1.7
1.2
1.4
1.6
1.1
1.7
1.7
1.3
1.6
1.7
1.3
1.8
1.8
1.4
8.1
7.4
6.4
5.9
5.5
7.7
7.5
7.3
7.0
6.6
6.5
6.3
6.1
-1,087
-680
-525
-475
-525
--
--
--
--
--
--
--
--
HOUSING MARKET
Housing Starts (units, thous)
New Home Sales (units, thous)
Existing Home Sales (units, thous)
Case-Shiller Home Prices (%yoy)*
INFLATION (% ch, yr/yr)
Consumer Price Index (CPI)
Core CPI
Core PCE**
LABOR MARKET
Unemployment Rate (%)
GOVERNMENT FINANCE
Federal Budget (FY, $ bn)
FINANCIAL INDICATORS
Federal Funds^ (%)
0.13
0.13
1.25
0.13
0.13
0.13
0.16
0.08
0.15
0.11
0.08
0.08
10-Year Note^
1.65
2.72
3.25
3.75
4.00
1.98
1.93
2.74
2.72
2.90
3.05
3.15
Euro ($/€)^
1.28
1.35
1.40
1.35
1.25
1.33
1.30
1.33
1.35
1.38
1.40
1.40
Yen (¥/$)^
81
100
110
115
125
93
101
98
100
103
107
109
Brent Crude Oil ($/bbl)^
110
111
103
100
100
108
103
112
111
107
105
105
* Weighted avg of metro-level HPIs for 366 metro cities where the weights are dollar values of single-family housing stock reported in the 2000 Census.
** PCE = Personal consumption expenditures. ^ Denotes end of period.
NOTE: Published figures are in bold.
0.13
3.25
1.40
110
103
Source: Goldman Sachs Global Investment Research.
Goldman Sachs Global Investment Research
6
March 7, 2014
US Economics Analyst
Economic Releases and Other Events
Estimate
Time
(EST)
Date
Indicator
GS
Consensus
Last Report
Tue
Mar 11
10:00 Wholesale Trade (Jan)
n.a.
+0.5%
+0.3%
Wed
Mar 12
14:00 Federal Budget Balance (Feb)
n.a.
-$206.0bn
-$10.4bn
Thu
Mar 13
8:30 Retail Sales (Feb)
+0.2%
+0.2%
-0.4%
Ex Autos
+0.1%
+0.2%
Flat
Ex Autos, Bldg Materials & Gas
+0.2%
+0.3%
-0.3%
8:30 Import Price Index (Feb)
n.a.
+0.7%
+0.1%
8:30 Initial Jobless Claims
n.a.
330,000
323,000
8:30 Continuing Claims
n.a.
2,908,000
2,907,000
n.a.
+0.4%
+0.5%
8:30 Producer Price Index (Jan)
+0.3%
+0.2%
+0.2%
Ex Food & Energy
+0.1%
+0.1%
+0.2%
81.0
82.0
81.6
10:00 Senate Banking nomination hearing for Fischer, Brainard and Powell
10:00 Business Inventories (Jan)
Fri
Mar 14
9:55 Reuters/U. Mich Consumer Sentiment—Prel (Mar)
Source: Goldman Sachs Global Investment Research.
Goldman Sachs Global Investment Research
7
March 7, 2014
US Economics Analyst
Disclosure Appendix
Reg AC
We, Jan Hatzius, Alec Phillips, Jari Stehn, Kris Dawsey, David Mericle, Shuyan Wu and Michael Cahill, hereby certify that all of the views expressed in
this report accurately reflect our personal views, which have not been influenced by considerations of the firm's business or client relationships.
Disclosures
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8